The Pre-Commitment Approach in a Model of Regulatory Banking Capital
FRB Richmond Economic Quarterly, Vol. 83, No. 1, Winter 1997, pp. 23-50
28 Pages Posted: 19 Nov 2012
Date Written: 1997
The pre-commitment approach offers a novel way to improve bank capital regulation. It requires that banks choose their capital levels and that regulators fine them if losses exceed this level. In essence, the approach is a proposal to use menus of contracts, a device commonly employed in other economic settings. Using a private-information model, the author derives optimal fine schedules and compares them to the proposal's schedules. He shows the latter schedules to be inefficient and potentially to require high levels of fines.
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